The Punch Insider Trading Case: A Peek at Einhorn on the Job

Peter Foley/Bloomberg NewsDavid Einhorn, chief of Greenlight Capital, was fined about $11 million last month in the insider trading case.

Greenlight Capital’s David Einhorn has gained a reputation as one of the sharpest hedge fund investors around. Thanks to the British financial services regulator, we have some new examples of his mind at work.

Mr. Einhorn gained a bit of a black eye last month, when he was fined $11 million by the Financial Services Authority after being accused of improperly trading on confidential information about the British pub operator Punch Taverns.

According to the British regulator, by selling its Punch shares ahead of a stock offering — which Greenlight had been improperly briefed on six days earlier — Mr. Einhorn and his firm avoided about $9 million in losses.

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In announcing the latest fine associated with the case, the Financial Services Authority on Thursday released the full transcript of a June 9, 2009, conference call between Mr. Einhorn and Punch’s chief executive, Giles Thorley. We have collected some of the highlights.

The call starts with some niceties:

Thorley: Okay. That’s fair enough. Well, one day we’ll get you around on a pub crawl around some English pubs.

Einhorn: Oh, that sounds fun.

Here is a considerably long and unbroken passage by the hedge fund manager explaining his view of the stock:

Einhorn: Right. You know, it seems to me that — that much of the potential attractiveness of coming and selling equity at this point stems from probably the fact that a few months ago the equity was at 40 pence, and now it’s at a £1.60 or something like this. And so, it’s up from the bottom. On the other hand, if you look back a couple of years ago, it’s – – the equity is really down a lot. It trades at a very low multiple of the book value and, you know, the comp – the company — the equity continues to trade as if it’s really an option on the debt side of the capital structure. That’s — that’s the way that we look at it. And we think it’s a very cheap option because of the types of things that you’ve been — already been able to execute on, and I think that you’re going to be likely to be able to execute on, uh, going forward. I think that in — if the equity was — was overpriced and you had an opportunity to reduce the financial risk of the company, I think it would make some sense to considering equity at that point. But I think, if you just looked in a slightly different world and thought “Jeez”, if the stock had come from where it was and it had never gone to 40 pence but instead was sitting at 1.60, then 1.60 represented a new low, down from whatever previous higher price it had used to have been at, I don’t even think you would be considering selling equity at this point. And — and so, I think the mere fact that the stock went to some lower price is not reason to — to dilute the — to dilute the equity in a substantial way, you know, at this time. The — the next point would relate to, I guess, the amount, and I guess that would look — you could look at that two ways. I suppose if it was a very small amount of equity being raised it would not be all that dilutive, and so there wouldn’t be a reason to have a very big concern about it. But, on the other hand, if there was a small amount of equity that was being raised, it wouldn’t really solve any of the company’s intermediate or longer term risks. And if there’s a large amount of equity to be raised, well, then it’s massively dilutive, then it — it will dramatically — I — from my perspective, worsen the risk/reward from — from owning the stock. So, I — I would — I would suggest continuing executing what you’re doing right now, which seems to be doing very well. I agree with you, it seems like there’s going to be a lot of debt in different parts of the capital structure that seems like it’s going to be available at attractive prices, and I — and I wouldn’t allow myself to get browbeaten by convertible bondholders or, excuse me, Merrill Lynch investment bankers or whatever else, you know, that — that is more transaction oriented. I think we create a tremendous amount of value by selling, you know, by selling pubs at reasonable multiples of EBITDA and then repurchasing debt at big discounts, and we’re hoping as equity participants not to make 10 or 15 percent of a year, you know, as market equity, but we’re looking for a significant revaluation of this company on the basis that at some point the world looks at it and says, “Yes, you are — you — you — you have — you are clearly solvent, and you clearly deserve some kind of a multiple,” and — and the thing that would cut that off would be issuing so many equity shares that, you know, that – that — that the upside disappears.

Mr. Einhorn offers some advice to Mr. Thorley:

Einhorn: Then you — you don’t let the market dict — my advice to you is, don’t let the market dictate to you. You figure out what you think it’s worth, and then use the market as a opportunity to create value, which is something that I think you’ve been doing instinctively, if not explicitly, on — on the debt side of the balance sheet, and — and actually with some of the asset sales. You’re letting the market tell you what the opportunity is and taking advantage of it. So, why — why throw that aside for the purpose of — of figuring out what to do about the equity.

But things get considerably testier once Mr. Thorley briefs Mr. Einhorn on the big stock sale that Punch is planning. Here is what happened when the size of the offering dawned on Mr. Einhorn:

Osborne: If you were — if you were to roughly sort of work on the basis that you kinda took out the — the converts, and that’s something that gives you, say, 10 percent headroom in within both of the covenants, filed covenants.

Einhorn: Wow, wow. That would be shockingly horrifying from my perspective. Can you sell half the company just at a buck and a half — a Euro — a pound and half? Oh, no.

Then the hedge fund manager starts getting a little testy:

Einhorn: We’ve survived watching the stock go all the way to 40 pence, for crying out loud. But, man, this sort of like validates the worst fears, and it seemed to me like you’re — it seems like — it seems like you guys were really on a course towards figuring out how to manage the securitisations, manage the liquidity, manage the covenants, sell assets, you know appropriately, take advantage of discounts where available in the market, and, you know, this doesn’t — I don’t see that this gains us anything.

Later on, there is a curious statement by Mr. Einhorn that surely caught the eye of the F.S.A.:

Einhorn: Now, what that brings to my mind though is, you know, obviously we haven’t done your analysis, we haven’t done — signed an NDA; I don’t know that we’re going to sign an NDA, because we prefer to just remain investors, but from my perspective, and I’ll be just straight up with you, is that gives a lot of signalling value. And the signalling value that comes from figuring out the company has figured out that it’s not going to make it on it’s own is that we’ve just grossly misassessed the — you know what’s going on here. And — and that, that will cause us to have to just reconsider what we’re doing, which is not the end of the world to you.

More in the same vein:

Einhorn: Well, I look at — I don’t — I don’t mind — I don’t mind the concept of an NDA in the sense that we’re not going to, you know, pass on information to others that could, you know, be competitively harmful to you and so on and so forth. I — I am uncomfortable with an NDA that is going to, you know, restrict our ability to, you know, to transact.

Thorley: We’re — we’re well aware of that, and to the extent anything, we ever did anything like that, we would have to be — give you the — a clear understanding of the timescales, which that — that covers and the, you know, to the fact that the company will cleanse any — any conversation to allow you to trade in due course.

Mr. Einhorn has defended his actions, arguing that he did not believe he was receiving confidential information. He likened the F.S.A.’s actions to “something more akin to a traffic cop with a quota at the end of the month and a miscalibrated radar gun.”